1. May I welcome you to this first evidence
session on the 2002 Spending Review. In light of the Chancellor's
statement on Monday and the subsequent debate on that, would you
like to give a brief comment before we start?

(Mr Walton) From a macro-economic perspective,
there was not very much new in the statement from what we learned
at Budget time. The overall spending plans remain the same as
set out in the Budget, so really the Spending Review just provided
the detail of the split between departmental spending and annually
managed expenditure, as well

as the split by Department. But we knew that spending
was going to grow quite rapidly, we knew that current spending
would grow by 3.8 per cent a year in real terms over the planning
horizon, and that with public investment, you would have total
spending growing by 4.3 per cent per year. What we do know though
from the figures is that there was a very big increase in discretionary
spending, and on our own estimates, if you strip out debt interest
payments and unemployment benefits, discretionary spending during
the course of this parliament is actually planned to rise by 5.6
per cent a year in real terms, and that is in marked contrast
both to the increase in spending during the first term of this
Labour Government and relative to the period of Conservative office
in the previous 18 years. That is the very striking thing, that
you have this very rapid growth in discretionary spending. Again,
from a macro perspective, what this means is that at a time of
uncertainty, fiscal policy is continuing to provide quite a lot
of support to the overall economy, and that is a factor which
I think will probably help the UK economy to continue to out-perform
most other economies over the next couple of years. As far as
whether this causes any threat to the overall sustainability and
whether these plans are affordable, our own forecasts at Goldman
Sachs are actually quite similar to the Treasury's. We think it
is quite reasonable to take as a central assumptionand
I describe it as "central" rather than "cautious"an
estimate of trend growth in the economy of 2.5 per cent. If that
is right over the next few years, it looks as though the Government's
projections for the public finances look quite reasonable. The
Government's fiscal rules will continue to be met quite comfortably[1].

2. In terms of spending up to 2006, the figures
are in the books.
(Mr Walton) They are. Obviously, you can be blown
off course in two ways: either if the economy performs less well
than expected, and it is certainly the case that economic activity
is almost certainly going to be different from the precise path
set out in the Red Book, but as long as growth on average is around
2.5 per cent, the numbers look reasonably OK; and the other area
where you can obviously be blown off course is that it is not
easy to forecast tax revenues. With the best models in the world,
even if you get growth absolutely right, you can still quite easily
be blown off course on forecasting tax. But the forecasts that
were presented at Budget time do not seem to make any overly optimistic
assumptions; essentially, underlying tax revenue is only growing
at about the pace of the underlying growth in nominal GDP, and
that seems to be a reasonably cautious assumption to make. Obviously
things can go wrong. If they do, obviously the Chancellor will
have to come back and address that, but, as you look at things
at the moment, it is difficult to say that these numbers look
imprudent.
(Professor Talbot) I would not disagree with any of
that, but there are a few things I would add. Firstly, I think
some of the discussion about the levels of spending over the last
few days in the media almost give you the impression that we are
moving to Swedish levels of public spending, and I think we need
to get it into perspective. If you look at the figures in the
back of the CSR report, giving the total managed expenditure as
a percentage of GDP, over the whole period of the report from
1963 up until the forecast for 2005-06, the average is about 43
per cent of GDP over that whole 30-year period. It is quite interesting
that the forecast figure for 2005-06 is 41.9 per cent of GDP,
so it is actually still below the average for the whole of that
period, and it is considerably below the average, I must say,
for the period of Conservative government from 1979-96, which
was about 44 per cent of GDP on the same figures. So we are talking
about actually relatively modest levels of public expenditure
in historic terms still. Interestingly, the forecast in the specific
increases in this Spending Review go from 41.1 per cent of GDP
up to 41.9 per cent, which is only an increase of 0.8 per cent,
which is modest compared to the previous three years, which was
getting on for 2 per cent of growth. We are not talking about
huge amounts of public expenditure in historic terms or any massive
shift taking place. There are a couple of other issues I would
like to mention which I think have not been brought up very much
in the discussion so far. The first is the question of under-spending,
which we have not had any recent figures on but has been a problem
over the last three or four years. There have been considerable
levels of under-spending and considerable problems with getting
money particularly into investment programmes. As we know, at
the time of the last election, when there was a rather heated
political debate about whether or not the figures should be £8
billion less or £8 billion more, we were actually under-spending
by about £8 billion on the total figures, which is quite
ironic. I think there is a real danger that, in the rush to try
and get the money out to-front-line services and to get investments
made, there may be a problem about mis-spending in the future.
A number of commentators have already mentioned that there may
be problems in particular areas, and there is obviously a need
for vigilance there. The third point I would make on the macro
issues is that there has been some discussion about there being
a danger of the extra resources being absorbed by staff costs
in the public service. As we know, and the figures are quite clear,
public sector staff pay has fallen behind private sector pay quite
markedly. In my view, in order to get the levels of service that
we need in public services, particularly in the labour-intensive
services, there will be a need for a rise in staff costs, both
in terms of extra staff numbers and extra staff pay, to make sure
they are able to recruit the people they need to deliver the services,
and to have the level of morale that is necessary to deliver services.

3. The capital spend has increased a bit, and
that is tied to the fact that departments spend money, so there
is a bigger urgency about that now given the extra money for capital
spend.
(Professor Talbot) There is. There is evidence beginning
to emergeand last time I gave evidence to the Committee
there was not any clear evidence about whether or not PFI was
causing some delays in capital expenditurethat it clearly
is causing delays in some areas, getting money actually spent.
(Mr Walton) Also, since the Budget, we have had the
outturn for the last financial year, and net investment actually
came in at £9.2 billion, which was £2.8 billion below
the estimate given in the Budget. So, as Colin says, there is
still some evidence that it is taking time for all this investment
spending to come through.

Mr Plaskitt

4. Staying with the macro situation for the
moment, a lot of the independent forecasters are pulling their
growth estimates down for this year and also for next year. Are
you not bringing yours down, did you say?
(Mr Walton) We are not actually. Clearly, there is
a lot of uncertainty about the global economic outlook, and all
the volatility that is taking place in the financial markets is
adding to that uncertainty. But it does actually look as though
the Chancellor's forecast for the current financial year is still
quite reasonable. When we get the second quarter GDP numbers,
which are out a week this Friday, those are likely to show a very
strong rebound, we think, in the second quarter. Industrial production
has certainly rebounded very strongly, and consumer spending has
remained very strong. So we could easily see a one per cent or
more quarter on quarter rise, and if we get that, that is going
to give a good start to growth in this current financial year.
The main point is, whatever the uncertainties about growth in
the very near term, unless you think that trend growth in the
economy has suddenly come down, the implication is that if growth
this year turns out to be weaker, then inflation will tend to
under-shoot the target, and we are already seeing inflation quite
considerably below the target. That would mean that there is then
scope for growth to be that much faster in future years. So if
you are taking a five-year view, it is certainly not unreasonable
to think that growth is going to be averaging somewhere round
the 2.5 per cent level, which is implied in the Government's projections.

5. I think we have to look at it across the
whole of the three-year run. What do you think about the first
year of it though? That could be a year when the economy somewhat
under-performs on growth against Treasury expectations, and if
I am reading the figures rightly, there is quite a surge in additional
spending come through in the first full year, 2003-04. So in the
year when the tax revenues might be coming down a bit lower than
expected, the spending is going right up. Will you get one year
where borrowing looks too high before it corrects in years two
and three?
(Mr Walton) I think there is that element in the profile
anyway, in that the tax increases that were announced in the Budget
really kick in from next year; they do not kick in at all this
year. In fact, there is a net tax cut of £1 billion or so
for this year. Clearly, if you were to get shortfalls in growth,
that would tend to also dampen tax revenue at a time when, as
you say, the spending numbers are growing quite rapidly. On the
Government's own projections, they are expecting to see public
sector net borrowing of £11 billion this year, versus the
outturn we now know of a surplus of £1 billion for last year.
That is embodied already in the Government's projections, and
clearly it could turn out to be worse than that if growth is lower.
But the other point to remember is that the Government's fiscal
rules are judged over the entire economic cycle, and so again,
to the extent that output is falling a bit below potential, you
are allowed on the fiscal rules to actually have borrowing a bit
higher than would normally be the case, providing that it comes
back down again as the economy moves back to trend.

6. Borrowing has gone up a lot, has it not?
At the time of Budget 2000 the projected cumulative borrowing
for the three years of this Spending Review was £11 billion
and it is now projected at £43 billion. Is it still consistent
with the Golden Rule?
(Mr Walton) I think so. If you look at what has happened
in recent years, the Government has actually more than surpassed
achieving the Golden Rule. In 2001 they had a current budget surplus
of 2.2 per cent of GDP. Last year they had a surplus of 1 per
cent of GDP. The Golden Rule is that over the cycle you should
have either balance or a surplus. So when you bear in mind that
already you have locked away quite large surpluses, and indeed,
over the projections that the Government has, by the end of the
forecast horizon you are still running a surplus of three-quarters
of a per cent of GDP. Even if you were to get some shortfall in
the next year or two, I think that would still leave the Golden
Rule being met quite comfortably over the full period. Certainly,
on the net debt ratio, where the objective is to keep net debt
below 40 per cent of GDP, that is running around 30 per cent at
the present time, and you would have to have very substantial
over-shoots in public borrowing to get you anywhere close to a
40 per cent of GDP debt ratio.

7. So on the basis of what you are saying, it
does not sound as if there is any gambling going on.
(Mr Walton) If you are looking at the period covered
by the Spending Review, it is almost certain that we are going
to see the Government's fiscal rules still being achieved. There
may well be some questions as to what happens in the period after,
and obviously that is going to depend on what the Government decides
it wants to do with spending and taxes, but for the next three
years after the current year, certainly on Goldman Sachs's forecast,
we would expect the Government to meet their two fiscal rules
quite comfortably.
(Professor Talbot) The only thing I would add on the
gambling issue is that I think the gamble is more a political
gamble than a fiscal gamble. It is fairly clear that the perception
that is being created is that the Government is throwing huge
amounts of money at public services and if that does not solve
the problems, then all sorts of issues will flow from that. I
think that is probably right in terms of the politics of it. In
terms of the fiscal issuesand I do not do economic forecasting,
so I have to rely on everybody else's forecastsI certainly
have not seen anything that seriously challenges those sorts of
central assumptions.
(Mr Dilnot) The only thing I would add is that I entirely
agree with what David has said about the fiscal rules. The sense
in which there is any gambling, though, is that forecasts of the
public finances, even done by the Treasury, are on average wrong
by quite a lot: £11 billion, even for just one year ahead,
more than £40 billion for four years ahead. That is not a
criticism of the TreasuryIFS and Goldman Sachs, who of
course are at least that good, get it wrong on occasions as wellbut
it does remind you that we do not know with certainty what the
public finances will look like even next year, and because the
Chancellor is now running with a higher estimate of the trend
growth rate of the economy, he is closer to a central forecast,
so there is less scope for, if things go wrong, the fiscal rules
not to be broken. If, for example, we were to see an unexplained
deterioration in tax revenues that matched the unexplained improvement
in tax revenues we saw in the first parliament of the Labour Government,
then I think there is more chance of a problem. So I think there
is more of a gamble than there was in the first parliament, simply
because the forecasts for the economy on which the public finances
are based are no longer systematically pessimistic, but they are
much more central, so if something goes wrong, the risks have
become greater, but I do not think we should exaggerate that risk.

Mr Tyrie

8. I wanted to ask Mr Walton about City analysts'
approach to estimating public borrowing. Do City analysts look
carefully at contingent liabilities that have come with the massive
increase in PFI? Do they tack that on as a rough estimate of what
they think the borrowing outcome might be, or are they largely
ignoring it?
(Mr Walton) I cannot speak for all City analysts.
The only thing I would say is that there is not a lot of information
on the PFI and the liabilities that result from that in the public
domain other than that provided by the Treasury, so to a large
extent we do have to rely on the kinds of numbers that the Treasury
provides in that particular area. It is much easier in a sense
to forecast tax revenues because, notwithstanding the errors in
forecasting, at least you would expect over time taxes broadly
to maintain a reasonable relationship with overall growth in nominal
incomes in the economy. You always have to make a judgement as
to what the Government says it is planning to do, whether it is
actually going to stick to those commitments or whether at some
point they are just going to change. As I say, in certain areas,
particularly to do with capital spending, there is not really
a lot of independent information available that analysts can look
at. We are largely beholding to the Treasury.

9. So on the basis that there is not much information,
City analysts are not tacking a little bit extra on to the estimates
of borrowing to take account of the possibilityindeed,
the likelihoodthat there will be some contingent liability
flowing from PFI contracts?
(Mr Walton) My general view at the moment, and given
the Government's track record to date, is that it has been quite
reasonable to assume that at some point during the course of the
spending round you tend to get some upward revisions to spending
plans. So to build in some kind of provision for that I think
is quite reasonable.

10. I am asking a very specific question about
PFI and PPP, not a general question about whether spending tends
to under-shoot or over-shoot.
(Mr Walton) I think the issue then is largely is this
catered for within the various reserves that are set out by the
Government? I would have thought, given the overall size of these
liabilities, the various reserves would account for that, but
obviously if you then had some other big shock on top of that,
you could run into difficulties.

11. I do not want to put you too much on the
spot but just to get a feel for, as one of the country's leading
analysts, whether you happen to know roughly what the total PFI
signed deals or deals at preferred bidder status are, what the
value of them is in the public accounts.
(Mr Walton) Off the top of my head, I do not have
that figure.

12. Do you know what the figure is by order
of magnitude?
(Mr Walton) Certainly we have seen tens of billions
of contracts signed. As I understand it, the actual flow expenditure
is still in single billions. I do not know whether my colleagues
can comment.

13. The annual flows are in single billions.
The cumulative capital value is £50 billion. One last question:
if I told you it is a fact that a high proportion of this information
is in the public domain, but it is published in individual departmental
accounts, not largely in the Red Bookthere is a little
information in the Red Bookdo you think, in the light of
the exchange we have just had, awareness may grow about this and
this might be something City analysts ought to start to look at?
(Mr Walton) When I say we have to rely largely on
the Treasury, the Treasury Red Book does summarise all of that
information contained in the departmental reports. I am taking
the Treasury as a proxy for the whole of government here. The
information is clearly there about the contracts which have been
signed and how much the Government expects to pay in terms of
the ongoing servicing of these PFI contracts. I am not sure that
there is much further independent information that is available
that would enable you to actually say those numbers that the Treasury
have put down in the Red Book are not reasonable central estimates.
Clearly, in your forecasts you may want to build in a margin of
error if you think there are good reasons for thinking that actually
spending may be greater, but if we are talking about £5 billion
or so of annual expenditure, in terms of the errors that Andrew
was talking about in forecasting the public finances, if the error
is £1 billion on the amount of spending on servicing PFI
contracts, which would be a very large error, clearly, that would
still be relatively small in terms of the overall errors that
we can make in forecasting.

14. I think we are talking apples and pears
here. There is the cost of servicing the contracts, which is set
out in a clear table at the back of the Red Book, which is in
the range of £4-5 billion per annum running for about 40
years. That is not what I am talking about. I am talking about
whether the estimates of what might happen to long-run borrowing
made by City analysts are taking into account the possibility
that some of the risks associated with these contracts have not
in fact been transferred to the private sector, that they are
covered by letters of comfort or by just common sense, that we
know some of these projects, once begun, cannot be reversedthe
Government cannot leave a half re-done Underground systemand
that therefore in practice there are very large contingent liabilities
not in the bottom line of the accounts. This constitutes off-balance
sheet finance, which City analysts might want to take a look at.
The answer to my first question was you are not looking at this.
(Mr Walton) If you are saying that there are potential
liabilities that you may have to pick up in the future, by and
large those probably will never figure, actually, in public sector
net borrowing, because a lot of these will be financial transactions
which will be below the line. They will clearly add to government
debt over time, but they are not necessarily ever going to figure
in the Golden Rule or indeed in public sector net borrowing. If
we still had the old public sector net cash requirement as an
objective, then they would have an impact there, but again, given
how low the level of public sector debt is, particularly relative
to the 40 per cent ceiling that is set out by the Government,
and indeed low relative pretty much to any other European country
that you look at, if you were talking about the sustainability
of the public finances, I would not have thought there was a great
deal to be concerned about at the moment about these contingent
liabilities suddenly leading to a big explosion of government
debt.
(Mr Dilnot) The only thing I would want to add is
that I think in all of this we are often hampered by focusing
too much on annual flows of borrowing. If we were thinking about
a company, then we would be very concerned about the balance sheet,
a balance sheet properly constructed, and this kind of issue is
precisely where a national public sector balance sheet really
would help. Such a balance sheet certainly ought to take account
of what is happening to explicit liabilities in the form of pension
promises, and you would expect it to take some note of these kinds
of contingent liabilities. As David said, were a disaster to occur,
say on the Underground, it is not so much the impact of that on
long-run annual borrowing; there would tend to be a big hit on
the balance sheet in the year in which it happened. So I think
as much as the concern about whether or not this is taken into
account in forecasts of the annual flow of borrowing, the real
problem is that we do not focus enough on the balance sheet as
opposed to the annual flow of borrowing, because as far as the
annual flow of borrowing is concerned, that is not really what
is at stake in these kinds of contingent liabilities, over which
there is a genuine debate to be had about whether they should
be classified as public or private sector, not because of what
it would do to the annual flow of borrowing but because of what
it would do to what we think the net worth of the public sector
carried forward is.

Mr Tyrie: It appears that these numbers
have not yet been given the scrutiny they deserve.

Mr Cousins

15. Mr Talbot, I am really asking this question
because you are from Glamorgan, and you might be more interested
in these things than most people in London are. How is under-spending
and over-spending dealt with in the Barnet formula?
(Professor Talbot) I do not know.

16. You said there was beginning to be evidence
that the process of PFI was slowing down spending. Mr Walton came
in then with a comment that the outturn figures were, if I recollect
what he said, £2.8 billion of planned public investment last
year failed to occur, which was quite a high proportion of the
total. How much of that under-spending on public investment would
you attribute to PFI and its delays?
(Professor Talbot) That is impossible to estimate.
The evidence that PFI contracts are causing delays is purely case
study-based. It is difficult to translate that into general figures.
I could not say.

17. You also mentioned pay. In the section on
the public sector labour market in the Comprehensive Spending
Review there is a sentence on page 151 which reads, "The
public sector still maintains widespread national pay determination,
which can limit the ability of individual employers to respond
to local labour market conditions. Local flexibility on pay and
non-pay matters offers a targeted solution." Do you think
that presages an undermining of the present national pay negotiations
on public sector pay to produce great regional disparities?
(Professor Talbot) The issue of trying to introduce
regionalised, localised pay in the public sector has been going
on for 25 plus years. The Treasury has always had it dear to its
heart, and they have never succeeded yet, and I very much doubt
it is going to happen now. One of the areas that I have studied,
for example, is executive agencies in the Civil Service. One of
the original points in that was that it was going to lead to regionalisation
of pay and pay being geared to local labour markets. By and large
it has not, even with a major structural reform like that. So
it is there as an aspiration, but I suspect that is all it will
ever be.

18. Mr Dilnot, in your own paper to the Committee
on page 5 you make a reference to the Government's commitments
on child poverty. You seem to imply that, because of the scale
of the committed spending, there will be not much left to sort
out either pensioners or child poverty, and that a choice might
have to be made between them. That is how I read what you are
telling us. Is that right?
(Mr Dilnot) I think what I say is that the Pension
Credit, when it comes in in full, will itself have a very significant
impact on pensioner poverty, and indeed, there is a good chance
that the Minimum Income Guarantee will take pensioners just above
the 60 per cent of mean income, so many of the poorest pensioners
may just be taken above the poverty line. Our concern as far as
the Government's targets is concerned is much more about child
poverty, where the Public Service Agreement is still committing
the Government to reducing child poverty by a quarter from 1998,
and where the latest results show that far from child poverty
having fallen by 1.2 million, it has fallen by 500,000, so the
Government is some way away from meeting that target. Of course,
the Child Tax Credit, the Working Tax Credit, come in next year,
but our estimates are that even once that has happened, very significant
further increases in spending on benefits targeted on children
in low income families will be necessary for the Government to
hit its poverty targets, and that is money which does not appear
to be visible here. Of course, some of that money will come in
AME rather than being part of the Spending Review process, and
so one of the ways in which the spending plans that were set out
two days ago may well turn out to be flaws is that I think if
the Government is to make significant progress on its child poverty
target, it simply will have to allocate significantly more money
to children in low income families year by year, but that is not
cheap. Estimates that we produced at the time of the last poverty
figures were that to get towards meeting its target, the Government
might well need to allocate an extra £10 billion a year,
1 per cent of GDP, and that money is certainly not evident in
these spending plans.

19. What about pensioners? (I want to declare
my interest, as a man of 58!)
(Mr Dilnot) There is not an explicit target on pensioners.
I trust, Mr Cousins, that you are looking forward to enjoying
the Winter Fuel Payment. Pensioner poverty, which has already
been significantly reduced by measures taken so far, will be significantly
reduced again by the introduction of the Pension Credit, and we
nearly have a commitment from the Government to increase the Minimum
Income Guarantee in line with earnings for the rest of this parliament.
So on pensioner poverty, I think the funds allocated are already
here, because I think the policies on pensioner poverty that have
been described will have a significant impact. I think there is
much more of a problem over poverty amongst children than there
is poverty amongst pensioners as far as the Government and its
policies are concerned.
(Professor Talbot) To come back on your question about
the Barnet formula, I have been thinking about it while we have
been talking. As far as I can remember, the formula is entirely
based on planned expenditure, so changes in outturn would not
have any effect on it at all.